Genius is A Rising Market! Prudent Investors as Contrarians (UPDATED)

``Believing that the market is “wrong” is one of the worst mistakes a trader can make. When an investment goes against an ego driven trader, they tend to play the blame game. It must be the economy... the Fed... the price of oil... bad earnings from another company in the sector. In other words, the blame is placed on everything, except for their own infallible analysis.”-Charles Delvalle, Investor’s Daily

FOUR years ago, when I began this crusade, the stock market was anything else but attractive. Following the meltdown sparked by the Asian Crisis, the Phisix was practically a bête noire. No one wanted to touch or even discuss about it, everyone was “risk averse”, and news about stocks were relegated to the inside pages of business dailies. I even recall my principals photographed in prayer alongside all other brokers at the trading floor, signifying desperation for a turnaround then.

As the Phisix entered to its nadir following several years of gut-wrenching downturn accompanied by intermittent rallies, hardly anyone had the gumption to talk about market fundamentals such as earnings, revenues or economic turnaround simply because sentiment or market psychology was dour.

In several occasions, peso volume turnover even hit less than 100 million pesos. More remarkably, despite the record revenue and earnings, PLDT was sold down to a low of Php 209 pesos per share during the last quarter as foreign money sold on the issue in line with the furious selling in the telecoms issue worldwide. The following year a foreign broker even declared our market going nowhere.

Except for two brave souls who dared enter the market then, basically everyone I knew of shunned the prospects of recovery and had written off stocks entirely. There are those whom I recommended to rejigger their portfolios and they reacted by selling out and have not seen them return since.

TODAY, with the Phisix registering over 150% of gain since then, almost every active participants have come up with diverse rationalities to justify their positions, to name a few, growing earnings, rising sales, expanding production, low price-earning ratio, stock buybacks, a cash hoard, a jump in dividends, mergers and acquisitions, backdoor plays or even an economic turnaround.

To assert that the market had been driven by foreign fund flows underpinned by the globalization of the financial markets, which has likewise steered on the advancing phase of our stockmarket cycle is simply unacceptable to many simply because such is partially premised upon luck. Foreign money represents externalities. Except for me, no one wants to be called “providential”, as present successes have to be attributed to skills in stock picking. In short, in general no one wants to be deemed as having been “Fooled by Randomness” to quote mathematician trader Nicolas Taleb.

Based on Pinoyfinance.com data, as the Phisix is up by over 20% year-to-date, of 264 issues listed (265 ex-Tuna Alliance) 176 issues have advanced (as of October 16) or 66.67% compared to 15.5% decliners while the rest are unchanged. This translates to about 7 advancing issues for every 10 issues. Put differently, as the market advances, the gains have been broadening as the public becomes more convinced of the persistence of such progress.

As I have previously argued, the markets are essentially an expectations game and expectations then and today have radically evolved. This is also evidence of how the axiom “Rising Tide lifts all boats” has been unfolding. You don’t need a guru or a star analyst to tell you that; expect everyone in the know to highlight or bruit about their share of “ability-based” glory. Yet, truthfully as the gains accrue, publicity aside, to quote a Wall Street maxim, ``Even Turkeys fly in Strong Winds”.

Essentially it is not much about picking a winning stock, but rather how one manages such gains or one’s portfolio under such environment. As they old proverb says, ``the proof of the pudding is in the eating.” It is widely known abroad, that active fund management or fund managers (no matter the sophistication of their methodologies), in general, has failed to beat the benchmark indices. According to a study by Investment Managers, Tweedy, Browne Company LLC (emphasis mine), ``Empirical research concerning successful long term investment results indicates that under-performing the S&P 500 25%–40% of the time is not uncommon for successful investment managers. In fact, it appears to be normal. Investors who understand this are more likely to stick with a perfectly valid long-term investment strategy in the inevitable and, we believe, normal, under performing periods. It is all too human, in the field of investing, to extrapolate recent results, which have no statistical significance, rather than emphasizing long-run odds and empirical data. Your own psychology and ability to handle the emotional ups and downs of investing are likely to be important determinants of your long-run investment success.”

All these could be summed up in 5 simple words: Genius is a Rising market!

Of course, as conveyed above, one may argue that some issues may outperform. That is true. But altogether, as the market advances the gains will percolate over the broader market. The public will be more confident and complacency will set in. That is the general function of cyclicality. Yet, this is where the prudent investing comes in play, because complacency increases the risks factors.

NO trend goes in a straight line, though. There will be bumps along the way. Although markets will be accommodating as it appears to be in an upside cycle, there are “tail” risks involved. And these risks, once realized could leave investors holding an empty bag or even delay or reverse the present cycle. And this has been the thesis of my discourse since.

AS practicing Prudent Investor, my self-assumed role is to challenge or question the conventional or popular wisdom, even if, at times, I do agree with the prevailing premises. By playing the devil’s advocate, we decrease our tendency to get “married to a position”. It is by nature of prudent investors to be contrarian.

Because my concern is about risks, I try to identify them and the possibilities or probabilities and adjust accordingly on my approach to the market. And this through my letters I share with you.

IT is not my intention to offend anyone and if I do come on strong at times, I seek your understanding. I just feel, that growing complacency arising from consensual wisdom, popularity and/or inordinate cheerleading represents greater risks and therefore, to my limited audience, a word of caution. I do not expect you to agree with me, but to my perspective it is imperative for me to disseminate or impart the message of risk control. It is up to you to exercise caution. Doing your own homework is the best way to reduce risk.

I have also outlined to you the conflicting income goals of a broker and an investor, such that it is the responsibility of investors to be aware of such disparities and act accordingly.

EVEN relative to governance I come to debate on the conventional thoughts. Nurtured to believe that governments are everything in our lives, I only come to realize only in the last two years, influenced mostly by the Austrian School of Economics, or the Ludwig Von Mises Institute, that governments by its intrinsic nature play a big role in inhibiting progress. Look no further than reading your history books or at the unraveling developments around the world today.

I have actively marched the streets in the past revolutions and found to my dismay that the changing of guards for a dream of a better alternative has not led to any manifest progress. I came to realize that the decadence of the state of the country’s economy emanates mainly from an enlarged government bureaucracy, an offshoot to the deeply embedded dependency or welfare culture.

In principle, the larger the government, the risks is of greater inefficiency and more bureaucratic corruption, aside from, of course, competition for resources with the private sector thereby choking market forces, which dampens the entrepreneurial “animal spirits” (Keynes) and impedes economic progress.

Changing of guards or forms of government would most likely be unsuccessful unless it reduces the participation of government in the economy. It is called “economic freedom” to some institution. Yet, mainstream media continues to highlight otherwise. I have thus argued for freer markets and lesser government as a challenge to the conventional wisdom.

As you can see, my contrarian approach requires an open and flexible mind while at the same time continually challenge the premises of our underlying biases.